How to Calculate Net Capital Spending (With Useful Tips)

By Indeed Editorial Team

Published 11 July 2022

The Indeed Editorial Team comprises a diverse and talented team of writers, researchers and subject matter experts equipped with Indeed's data and insights to deliver useful tips to help guide your career journey.

An accountant's job can be fulfilling for those who enjoy working with large numbers and figures. Accountants regularly perform many different tasks, which may include calculating the net capital spending of a company or a client's firm. Learning how to calculate it with precision may help you perform well at work or display your professional competency to a hiring manager. In this article, we define net capital spending, explain how to calculate net capital spending, provide an example for such calculation, suggest how often to perform it and offer tips on doing it accurately.

Related: Why Is Accounting Important? With Benefits of Accounting Career

What is net capital spending?

Before you learn how to calculate net capital spending, it may be important to understand what this term means. Net capital spending refers to the amount of money that a company spends on purchasing new capital. Some professionals in the industry refer to net capital spending as capital expenditures, or CapE for short. Accountants or investors may determine a company's net capital spending for a certain period of time to assess its performance.

How to calculate net capital spending

Finding out how to calculate net capital spending properly may help you improve your performance at work. Professionals typically use the following formula for this calculation:

Net capital spending = Ending value of net fixed assets - Beginning value of net fixed assets + Depreciation expense for current time period

Here are the steps to calculate net capital spending:

1. Determine the relevant time period

The first step in calculating a company's net capital spending is to determine the relevant time period that you want to consider. For example, this could be a period of six or 12 months. You may want to find out the net capital spending of a company over various time periods to better analyse its performance over different portions of a fiscal year.

If you wish to compare the net capital spending of a company over an extended period of time, it's usually best to use the same time frame for each calculation. For example, if the previous year's calculation was for a three-month period, you can use the same period in your present calculations. This can ensure consistency and a better comparison between various net capital spending figures.

Related: What Does an Accounting Clerk Do? Duties, Skills and Salary

2. Find beginning and ending values of net fixed assets

The next step is to determine the beginning and ending values of the company's net fixed assets. These generally refer to the physical inventory, equipment and other items a company owns, such as plants and properties. You may review the company's financial statements at the start and end of a chosen time period so you have two relevant figures for your reference.

By doing so, you can determine the total net fixed assets of the company over a specific period. Note that there may be instances where you add the various net fixed assets visible on the financial statement to determine their total value. The types of net fixed assets a company has may also vary between the beginning and end periods.

Related: What Is Gross Profit Ratio? (Plus How to Calculate It)

3. Calculate the depreciation expense for the time period

You can calculate a company's depreciation expense for a specific period from the income statement. Depreciation expenses refer to the money that the company loses due to damage to its equipment, plants or property. Such costs are normal and are typically due to the prolonged use of equipment.

Related: What Is the Total Cost Formula? (Plus How to Calculate It)

4. Put net fixed asset values and depreciation expenses into the formula

The last step is to use the following formula:

Net capital spending = Ending value of net fixed assets - Beginning value of net fixed assets + Depreciation expense for current time period

Subtract the figures from step two from one another and add the figure you've obtained in step three. This gives you the company's net capital spending over the chosen time period. Consider repeating the calculations to ensure that you have accurate figures. You may also repeat steps one to four to perform the calculation over different time periods.

An example of calculating the net fixed assets

Assume that a company wants to find out its net capital spending over the last 12 months. The net fixed assets in the beginning of the 12-month period equal $100,000, while they amount to $120,000 at the end. Its depreciation value over that period is $50,000. Applying the above formula, the company's net capital spending is as follows:

$120,000 - $100,000 + $50,000 = $70,000

How can you interpret net capital spending?

The figure you obtain for net capital spending may be large or small. These results may have different implications, as each company can be at a different stage of development. Here are some ways to interpret the net capital spending amount:

Determine what a large net capital spending may indicate

A large net capital spending may indicate that a business is growing or expanding rapidly. That's because a company in its expansion or growth phase may purchase significant volumes of equipment and facilities necessary to perform its work. Such acquisitions typically help to support the increase in scale of its operations.

Another way to interpret large net capital spending is to assume that a company intends to convert their large cash reserves into assets, which it purchases in bulk. This may be helpful if it wants to protect itself from inflation. Conversely, investing in assets typically limits the company's spare cash, which means that liquidating its assets may be necessary if it needs cash in the future. Comparing net capital spending to cash flow can be useful if the net capital spending figure is high.

Determine what small net capital spending may indicate

A small net capital spending figure may indicate that a company is maintaining its existing size and isn't looking to grow or expand rapidly. It often shows that its present equipment and facility volumes adequately meet its needs. It may also mean that the company is operating at an optimal level, so expanding to draw additional profits is no longer necessary.

Tips for calculating net capital spending

Here are some tips you can follow to calculate net capital spending more effectively:

Integrate net capital spending into your financial strategy

It can be important for a company to consider its net capital spending when creating its financial strategy and regular budgets. Net capital spending can withhold financial assets and cash, so being aware of how much a company intends to spend can help regulate its cash flow well into the future. Taking the net capital spending into account can also allow the company to make any purchases it needs without using the resources necessary for other expenses, such as staff members' salaries or rent for the office premises.

Furthermore, approaching capital spending with a strategic perspective can help you make decisions that may lead to proper long-term investments. This means that a company may choose to invest in inventory and equipment that may yield long-term benefits instead of spending money on quick fixes. Proper capital expenditure can help the company continue its upward growth trajectory for a longer period of time.

Consider the lifetime of purchased items

The lifetime of items that a company purchases typically determines whether they fall into the category of expenses or capital expenditures. Capital expenditures refer to company investments, while items with shorter useful lives are expenses. Items or purchases with a useful life of less than a year are usually expenses, as their depreciation equals 100% and they offset their own purchase cost within the year.

Conversely, a capital expenditure may depreciate over multiple years. When calculating the net capital spending of a company, you typically exclude expenses. You can consider including them in the income statement instead.

Related: How to Calculate Capital Expenditures (Definition and Use)

Consider the industry

The net capital spending of companies may vary depending on the industry they operate in. Some industries require more capital investment since they use more expensive physical equipment. Companies that manufacture goods or provide utility or communication services often have higher net capital spending since they use a lot of tools, machinery and land to perform their work. When interpreting the net capital spending amount for a business, it may be useful to compare it to an equivalent value of its competitors to see whether it meets industry standards for companies of its size.

Distinguish between operating expenses and capital expenses

Capital expenses are investments, while operating expenses are regular costs that a company has. For instance, buying a building is a capital expense, while paying the utilities for that building is an operating expense. Sometimes, operating expenses and capital expenses can have different tax rules, so it may be important to know which category the costs you're calculating fall into.

Related: Capex vs Opex: Differences, Importance and Examples

Explore more articles